Thursday, December 01, 2011

How Will it All End?

What Exactly happens when a country withdraws from a currency bloc? The Economist has the best tictoc I've seen:

If a messy default is forced upon a euro-zone country, it might be
tempted to reinvent its own currency. Indeed, it may have little option.
That way, at least, it could write down the value of its private and
public debts, as well as cutting its wages and prices relative to those
abroad, improving its competitiveness. The switch would be hugely costly
for debtors and creditors alike. But the alternative is scarcely more
appealing. Austerity, high unemployment, social unrest, high borrowing
costs and banking chaos seem likely either way.

The prospect that one country might break its ties to the euro,
voluntarily or not, would cause widespread bank runs in other weak
economies. Depositors would rush to get their savings out of the country
to pre-empt a forced conversion to a new, weaker currency. Governments
would have to impose limits on bank withdrawals or close banks
temporarily. Capital controls and even travel restrictions would be
needed to stanch the bleeding of money from the economy. Such
restrictions would slow the circulation of money around the economy,
deepening the recession.

External sources of credit would dry up because foreign investors,
banks and companies would fear that their money would be trapped. A
government cut off from capital-market funding would need to find other
ways of bridging the gap between tax receipts and public spending. It
might meet part of its obligations, including public-sector wages, by
issuing small-denomination IOUs that could in turn be used to buy goods
and pay bills.

When cash is scarce, such scrip is readily accepted by tradesmen. In
August 2001 the Argentine province of Buenos Aires issued $90m of small
bills, known as patacones, to employees as part
of their pay. The bills were soon circulating freely: McDonalds even
offered a “Patacombo” menu in exchange for a $5 patacón. Argentina broke its supposedly irrevocable currency peg to the dollar a few months later.

Scrip of this kind becomes, in effect, a proto-currency. In a
stricken euro-zone country, it would change hands at a discount to the
remaining euros in circulation, foreshadowing the devaluation to come.
To pre-empt further capital outflows, a government would have to pass a
law swiftly to say all financial dealings would henceforth be carried
out in a new currency, at a one-for-one exchange rate with the euro. The
new currency would then “float” (ie, sink) to a lower level against the
abandoned euro. The size of that devaluation would be the extent of the
country’s effective default against its creditors.

Market gurus and other students of misaligned stock, bond or home
prices often say that although it is easy to spot an asset-price bubble,
it is impossible to know the event that finally pricks it. In much the
same way, the likeliest trigger for a disintegration of the euro is
unknowable. But there are plenty of candidates. One is a failed bond
auction that forces a country into default and sends a shock wave
through the European banking system. Italy has €33 billion of debt
coming due in the final week of January and a further €48 billion in the
last week of February (see chart 3). Since bond investors are turning
their noses up even at offerings from thrifty Germany, the odds against
Italy’s being able to raise the money it needs early next year are
uncomfortably short.

Another danger is a disagreement between Greece and its trio of
rescuers (the EU, the IMF and the ECB) over the conditions of its
bail-out. The risk of a mishap will be greater after the Greek elections
in February if the country’s political mood sours yet further. Perhaps
the spark will come from another source: the bankruptcy of a bank; fresh
trouble in Portugal; or a chain of events that starts with France
losing its AAA rating and ends with runs on banks across Europe. The
exposure of French banks to Italy and to other countries that have been
in bond traders’ sights for longer implies that contagion would quickly
spread to the euro’s core (see chart 4). Widespread defaults in the
periphery would wipe out a big chunk of Germany’s wealth and begin a
chain of bank failures that could turn recession into depression.
The few left in the euro (Germany and perhaps a few other creditor
countries) would be at a competitive disadvantage to the new cheaper
currencies on their doorstep. As well as imposing capital controls,
countries might retreat towards autarky, by raising retaliatory tariffs.
The survival of the European single market and of the EU itself would
then be under threat.

Link. The Economist ends its rosy scenariising on an encouraging note: "Such a disaster can still be averted." From your mouth to God's ear.

2 comments:

It has not been a secret—as in, I've heard it, and I'm not particularly in touch with the European HNW markets—that Greek plutocrats, whose skills at tax evasion are already legend, have been converting as much of their own holdings as they can into non-domestic assets for several months.

The thing about a bubble is that you can be early (e.g., Dean Baker sold his condo two years before the peak of the market) so long as the market doesn't "remain irrational longer than you can stay solvent." All you "lose" is opportunity to sell to an Even Greater Fool, against the possibility that, this time, there isn't one.

Which is why the FT headline yesterday (Wed), "Businesses plan for possible end of euro," falls into the "duh"category. The Fools are leaving the table, and playing your hand against the house is always a losing bet. Especially when the house didn't make the right moves 1999-2002, and now expect everyone else to continue to pay for its mistakes.

Captcha is something really close to "sit tight." Not good advice, though, as noted, it may be too late to do anything but ride it out.

Hey, California almost exited the reigning currency in favor of Patacones 3+ years ago when the state issued IOUs to their employees for what, 3 months?....as long as the banks believed they were good they functioned as de facto currency.